Brazil Removes Financial Transaction Tax as Currency Slumps

Brazil on Tuesday cut the financial transactions tax on overseas investments in domestic bonds from 6 percent to zero, a surprise move that could help stop a sharp depreciation of the real that threatens to stoke already high inflation in Latin America's largest economy.

The removal of the tax, known as the IOF, will take effect from Wednesday and removes a key defence measure Brazil had put up in late 2009 to prevent a surge in hot money inflows after developed nations loosened their monetary policies to stimulate their economies.

Brazil over the past few years has fiercely criticised loose monetary policy in the United States for creating a “tsunami” of liquidity that flooded into emerging markets, inflating their currencies and rendering their industries uncompetitive.

After the 2008 financial crisis, the U.S. Federal Reserve sought to jump-start the economy by pumping large amounts of liquidity into the markets, effectively weakening the dollar against currencies such as the Brazilian real.

Finance Minister Guido Mantega said the policy was tantamount to a currency war but U.S. officials denied the charge, arguing a strong U.S. recovery would be good for the world.

"Today, with the market returning to normal and the (U.S. Federal Reserve) likely reducing its expansionist policy, we can remove this barrier we had placed," Mantega said in a hastily arranged press conference yesterday.

While the government had previously advocated a weaker currency to help Brazilian exports, there are growing concerns that a sharp depreciation of the real could worsen inflation, which is already hovering near the top of the central bank’s target range.

The real has already lost 7.6 percent in the past three months, making it the worst performance among the seven major Latin American currencies tracked by Bloomberg.

In April, Brazil eliminated the so-called IOF tax on certain types of working capital for infrastructure, on operations to finance the purchase or leasing of capital goods, and on roads and railways concessions, among other infrastructure projects.

Analysts say the reduction of capital controls will likely help the real rebound from near four-year lows and ease pressure on inflation, which has turned into a political liability for President Dilma Rousseff as she prepares to run for re-election next year.

Chancellor of the Exchequer of the United Kingdom from 1992 to 2007. Prime Minister of the UK between 2007 and 2010. Inaugural 'Distinguished Leader in Residence' at New York University. Advisor at World Economic Forum